Apple Score

How unfortunate that most capital market stakeholders which include but not limited to the traders, analysts, investors, managers and regulators compared the business operations and financial performance of the public companies for the years ended 2019 and 2020 despite the unprecedented pandemic-driven economic crisis that wreaked havoc on business activities. How could someone with a rational investor mindset compare the pandemic-threatened 2019 with the pandemic-centric 2020? Although these years are poles apart and not comparable by any measurable metric or acceptable standard, most capital market stakeholders tolerated the sequential growth analysis without regard to the comparability of accounting information. Through the digital media platforms such as apps, blogs and websites and the traditional media platforms such as print, banner and broadcast, the financial press compared and reported the business operations and financial performance of the public companies for the years ended 2019 and 2020. Comparability refers to an accounting information quality that makes the financial statement comparable. An accounting information that is prepared using the same measurement procedures and reported using the same reportorial standards is considered comparable. Although the sequential growth analysis for the years ended 2019 and 2020 was prepared using the same measurement procedures and reported using the same reportorial standards, the results cannot be considered comparable. The pandemic-threatened 2019 should be considered as a normal period while the results should be considered as a normal growth but the pandemic-centric 2020 should be considered as an extraordinary period while the results should be considered as an extraordinary loss. The pandemic-centric 2020 was a period in which cost and expense mitigation and elimination were implemented to conserve cash position, manage debt obligations, renegotiate contract terms, reduce business operations, lower manpower headcount and suspend capital expenditures among others. Most public companies went on an unusual survival mode in which business operations were relegated to bare minimum rather than the usual competition mode in which business operations were geared to maximum capacity. Although the infectious disease and public health experts have been warning us for years that a pandemic involving an infectious respiratory disease virus is a plausible scenario, the low‐frequency and high‐impact characteristics of a pandemic makes it an extraordinary period that we should consider as an unpredictable event with adverse consequences. We believe that the pandemic-centric 2020 should not be considered in a sequential growth analysis to ensure an apples to apples rather than apples to oranges comparability of accounting information.

Duterte Project

Public investment is proven as the best form of public spending to increase economic output. This is the finding of the Global Infrastructure Hub from its analysis of more than 3,000 estimates of the fiscal multiplier from more than 200 academic studies. The research found that public investment has an average fiscal multiplier of about 0.8 within 1 year and about 1.5 within 2 years. Global Infrastructure Hub was formed by the G20 to provide dedicated resources to help implement the agenda on sustainable and inclusive infrastructure through action-oriented programs. At the onset of his government, President Rodrigo Duterte promised to increase government spending on infrastructure as percentage of Gross Domestic Product (GDP) at par with the global standards. His promise led to the development of the Build Build Build infrastructure development program which includes high-value infrastructure projects that are expected to increase the productive capacity of the economy and improve the business environment of the country. Based on the data compiled by the National Economic and Development Authority (NEDA) from 2011 to 2016, government spending on infrastructure as percentage of GDP averaged at 3.0%. But under the renewed infrastructure development program, government spending on infrastructure as percentage of GDP averaged at 4.9%. Despite the budget limitations caused by the pandemic, the government stated that government spending on infrastructure as percentage of GDP could increase to 5.7% in 2021. Although an elevated political risk due to the upcoming national election could prolong the unprecedented pandemic-driven economic crisis, investors should include infrastructure-related stocks in their portfolio as the country enters the golden age of infrastructure. Most of these stocks are undervalued by the market due to government bureaucracy rather than company fundamentals. Although the recent regulatory debacle with several infrastructure-related companies dented government reputation as a business partner, investors should remain steadfast and adaptable to the changing political landscape. The golden age of infrastructure has just begun and would usher in tremendous business opportunities to the infrastructure-related companies where investors could take part. Since most infrastructure-related stocks remain at oversold levels despite the muted community quarantine and modest market recovery, this could be the best time to include them in your portfolio and wait for the market to agree with the narrative that the golden age of infrastructure could be the goose that lays the golden eggs. Good things come to those who wait but only what is left from those who hustle.

Gate Crash

We should embrace change for constant improvement but there are some changes that create questions rather than answers. Confusion could lead to doubt and most investors demand an explanation from the Philippine Stock Exchange (PSE) when it announced its plan to ease the listing rules to allow more companies to go public and raise capital. For listing on the main board, the PSE proposed the removal of the P500 million minimum market capitalization and Earnings Before Interest, Taxation, Depreciation and Amortization (EBITDA) requirement and replace it with a 3-year cumulative net income. Moreover, the PSE proposed that companies should have a 3-year cumulative net income of at least P75 million, a net income of at least P50 million in the past year before listing, and a minimum total shareholders equity of at least P500 million. For listing on the emerging board, the PSE proposed the removal of the P100 million minimum authorized capital stock requirement and replace it with a P25 million paid-up capital. Moreover, the PSE proposed that companies should have a 3-year cumulative EBITDA of at least P15 million, a 3-year cumulative operating revenue of at least P150 million that increased by at least 20% in the past two years. The proposed amendments to the listing rules would encourage small companies with short operating history to list and increase the number of listed companies in the PSE. Compared to 932 in Bursa Malaysia, 724 in Stock Exchange of Thailand, 716 in Singapore Exchange Limited, 691 in Bursa Efek Indonesia, 380 in Ho Chi Minh Stock Exchange and 357 in Hanoi Stock Exchange, there are 272 listed companies in the PSE. For listing on the main board where most initial public offerings are listed, we are concerned that the removal of the minimum market capitalization and EBITDA requirement and replacing it with net income could encourage small companies with short operating history and unproven business models to go public and raise capital. Most investors are in favor of using EBITDA as a measure of business performance because it could show earnings before the influence of accounting. EBITDA is a dependable indicator of operational efficiency because it enables investors to focus on the core profitability without factoring capital expenditures. We believe that EBITDA is the preferable financial metric to use to evaluate whether small companies with short operating history and unproven business models deserve to gate crash into the roster of listed companies in the PSE.

Bad Bye

Most investors could not care less when a public company decides to delist its listed shares from the secondary market but there are some minority shareholders who felt shortchanged by the majority shareholders. Some argued that the tender offer price should be the same as the initial public offer price while some accepted the tender offer price rather than hold the untradeable listed shares. Historical cost method used in accounting where the price of an asset is based on its original cost when acquired cannot be used for the tender offer price because value changes over time. Although the voluntary delisting rules should not be blamed for the tender offer price, the Securities and Exchange Commission and the Philippine Stock Exchange should be commended for tightening the requirements for a public company to delist its listed shares from the secondary market. While the old voluntary delisting rules could be approved by the Board of Directors, the new voluntary delisting rules should be approved by shareholders who own at least 2/3 of the total outstanding and listed shares, at least 2/3 of the Board of Directors, and at least 2 of the independent directors. To further tighten the requirements for a public company to delist its listed shares from the secondary market, the new voluntary delisting rules require that the number of votes cast against the voluntary delisting should not be more than 10% of the total outstanding and listed shares, the minimum tender offer price should be higher than the highest valuation based on the fairness opinion and valuation report prepared by an independent valuation provider, and higher than the volume weighted average price of the listed shares for a year preceding the date of posting of the voluntary delisting disclosure. The new voluntary delisting rules expanded the supervisory capacity of the concerned government regulatory agencies on public companies that could be planning to support the short-term interests of the majority shareholders and elude the long-term interests of the minority shareholders. Those who have less in life should have more in laws and the new voluntary delisting rules are what we need to discourage public companies from delisting its listed shares from the secondary market at the expense of the public. We do know that the new voluntary delisting rules are not perfect but at least they serve the purpose of making it cumbersome for public companies to bend the rules without breaking it.

Bear Case

As the coronavirus infection rate escalates due to the absence of a coronavirus vaccine, the Philippines enters into an economic recession after the economic growth plunged to a new record low. We do know that the Philippines would enter into an economic slump due to the extension of the economic shutdown but what we do not know is the extent of the economic meltdown. Although the economic output as measured by the Gross Domestic Product (GDP) of -0.7% in 1Q20 was more than expected, the -16.5% in 2Q20 was worse than expected. The government tried to change the narrative by saying that despite the high inflation in 2018, delayed budget in 2019 and global pandemic in 2020, the Philippines have strong economic fundamentals as compared to the 1983 debt default, 1997 financial crisis and 2008 global recession. These infamous economic downturns pushed the Philippines on the verge of economic collapse and forced the government to take the lead to soften the hard impact of economic crash. Multidecade of countercyclical regulatory measures such as aggressive fiscal and accommodative monetary policies resulted to stable interest rates, positive credit rating, strong local currency, sound external sector and robust banking industry. But these economic gains could turn into economic pains as the pandemic thrashed most economic activities. The government stated that GDP projections had been reduced to -5.5% from -3.4% for 2020 and to 6.5% from 8.0% for 2021 to factor in the economic slowdown but we are not sure whether the Philippines could enter into a V-shaped economic recovery. Underemployment and unemployment rates worsened due to the enhanced community quarantine which restricted the movement of the population in response to the health protocols. Although the underemployment rate of 18.9% is below the recent high of 19.6%, the unemployment rate of 17.7% is above the recent high of 14.4%. The economic unrest could last longer than expected as millions went underemployed and unemployed. Even the employed were not spared as the government recommended to the private sector to implement pandemic-driven work arrangements such as work from home and work hours reduction. The government could not turn the economy around unless the economic solution is commensurate to the economic problem. Without private consumption, gross investment and net exports, government spending is the one that should take the wheel and steer. We do not have to be an economist to understand the bear case equation: no income + no spending = no growth.

Stuck Market

The new decade began with black swans that have shaken the nerves of most investors. After the economic damage caused by the Taal Volcano eruption and the regulatory debacle between the government regulators and the water concessionaires, the coronavirus epidemic in China is now a global pandemic. As the coronavirus continues to spread, the government declared a Luzon-wide enhanced community quarantine and placed the Philippines under a state of calamity. Based on the National Economic and Development Authority scenario estimates, economic growth as measured by the Gross Domestic Product could decrease to -0.6% in 2020 from 6.0% in 2019 if the coronavirus pandemic worsens. Before the health emergency becomes an economic catastrophe, investors rushed to escape from the meltdown. Fundamentals were thrown out. Technicals were thrown out. Fear of the unknown sets in and stocks were sold in haste. To stop the panic selling, the Philippine Stock Exchange amended its trading rules and adjusted the lower static threshold from 50% to 30% below the previous close. Although the clinical trial of an experimental coronavirus vaccine has started, it would not be available for general use for at least 12 months. The presence of a government lockdown and the absence of a coronavirus vaccine would make stocks vulnerable to collapse since no price is too low for a bear. The worse is yet to come so fasten your seatbelts and prepare for an economic crash that could lead to an unprecedented pandemic-driven economic crisis. We do know that stocks could plunge to new record lows but what we do not know is how low it could go. Although the coronavirus infection rate continues to escalate, the World Health Organization says that the coronavirus would be the first pandemic in history that could be controlled. Investors are taught to focus on value rather than price and when the latter is lower than the former then it is enough reason to buy. This could be a generational buying opportunity to those who have the financial strength to get stuck for a moment and weather the economic storm. Although we are entering a new era of severe economic downturn, this could be a chance to buy the oversold stocks of undervalued companies whose products and services we cannot live without. How long should you hold a stock? Warren Buffett says that if you do not feel comfortable owning a stock for 10 years then you should not own it for 10 minutes.

Water Damage

We are taught that investing in water concessionaires is a sound investment proposition due to the perpetual demand for water and wastewater services. The need for more water-related infrastructure prompted the government to extend the water concession agreement between the Metropolitan Waterworks and Sewerage System (MWSS), DMCI Holdings Inc (DMC), Manila Water Company (MWC) and Metro Pacific Investments Corporation (MPI) from 2022 to 2037. But investors were shocked when the MWSS revoked the extension of the water concession agreement after the Department of Justice (DOJ) stated that it had no legal basis while several provisions had been found to be onerous and disadvantageous to the government. Most notable were the provision against government interference in water rate setting and the provision against possible losses in the event of government interference. DOJ argued that these onerous provisions were the reasons why the Singapore-based Permanent Court of Arbitration ruled in favor of the water concessionaires and ordered the government to pay them an estimated P10.8 billion to cover the foregone revenue as a result of government refusal to increase water rates. Threats of expropriation and charges of plunder forced the water concessionaires to delay the water rate hike, abandon the arbitral tribunal award and renegotiate the water concession agreement. We do know that the willingness of the water concessionaires to cooperate would be advantageous to the government but what we do not know is whether investor confidence could recover from a regulatory debacle. The damage was done and investors would consider government contracts as a high-risk factor. Although the intention is to renegotiate government contracts with onerous provisions, the government should uphold the sanctity of contracts. Breaking the rules and changing the game would increase the Country Risk Premium (CRP) that could have adverse impact on valuation calculations. CRP is the incremental required rate of return which results from the increased risk inherent in an emerging market investment. Investors sold down the water concessionaires and based on the 52-week high and low share price performance, DMC decreased by 61.9% from P13.00 to P4.95, MWC decreased by 82.3% from P28.25 to P5.01 while MPI decreased by 49.1% from P5.28 to P2.69. Although the share prices bounced back from the 52-week low we expect them to consolidate in a narrow trading range until the water concession agreement is sorted out. Unless the regulatory environment becomes stable, investing in water concessionaires is an unsound investment proposition.

Party Rules

To strengthen corporate governance and shareholder protection, the Securities and Exchange Commission (SEC) will require all publicly listed companies to submit a policy on material Related Party Transactions (RPT) by October 28. RPT are allowed on condition that when it amount to at least 10% of the total assets, it must be considered as material subject to the Material RPT Rules. Transactions covering at least 10% of the total assets involve, on average, an amount of P3,498,121,059.28 taking into account the total assets of all publicly listed companies for the year ended 31 December 2017. Considering the magnitude and impact of these transactions to the financial position of the company and to the interest of its shareholders, the SEC considers 10% of the total assets of all publicly listed companies as the materiality threshold for RPT covered under the Material RPT Rules. The 10% of the total assets has been acknowledged by the World Bank as an acceptable threshold in determining the materiality for RPT based on international best practices. Based on the disclosure and reportorial requirements, the Advisement Report on material RPT must be filed within 3 days after the execution date of the transaction; the Material RPT Policy with accessible link must be posted on the website within 5 days from submission to the SEC; and a summary of material RPT entered into during the reporting year must be disclosed in the Integrated Annual Corporate Governance Report of all publicly listed companies. For non/late filing or incomplete/incorrect signature in the Material RPT Policy, the imposable penalties are a basic penalty of P10,000 and monthly penalty of P1,000, which will continue to accrue until the Material RPT Policy is submitted to the SEC. For non/late filing or incomplete/incorrect Advisement Report, the imposable penalties are a basic penalty of P30,000 to P40,000 and daily penalty of P200 to P400 without prejudice to administrative penalties that may be imposed by the SEC. Although all related parties of all publicly listed companies can be disqualified on the basis of a final judgment rendered by a court of competent jurisdiction against them for abusive material RPT, the imposable penalties are comparable to a slap on the wrist. Perhaps the SEC should increase the imposable penalties for abusive material RPT to stratospheric level or else related parties will have the ability to bend the Material RPT Rules without breaking.

Last Resort

Tough times never last but tough companies do. But there are some companies that cannot handle the pressure of intense competition and investor expectations. The latest among them is Travellers International Hotel Group Inc (RWM), owner and operator of Resorts World Manila, which will delist from the Philippine Stock Exchange (PSE) in response to the changing marketplace without compromising its business strategies to competition. Change is constant while competition is intense in the gaming industry so it is bothersome to hear a lame excuse from a renowned gaming company run by postgraduate degree holder management team. In accordance with the Securities Regulation Code of the Philippines and the delisting rules of the PSE, RWM will conduct a tender offer of up to 1.58 billion common shares held by the shareholders other than First Centro Inc, Adams Properties Inc, Megaworld Corporation, Asian Travellers Limited, Alliance Global Group Inc, Premium Travellers Limited, Star Cruises Philippines Holdings BV, and the members of the board of directors. Upon completion of the tender offer, at least 95% of the total listed and outstanding common shares will be held by the private shareholders. The tender offer will be from 19 August 2019 to 23 September 2019 while the delisting date will be on 15 October 2019. RWM will buy out the minority shareholders at P5.50 per share using the fairness opinion of PricewaterhouseCoopers and Isla Lipana & Company. Based on a weighted average cost of capital of 12%, the discounted cash flow approach yielded a fair value ranging from P5.00 to P5.80 while the market approach yielded a fair value ranging from P5.00 to P5.70. Despite a tender offer price at the higher end of the fair value range and a premium to the volume weighted average price of P5.49 for the past 3 months and P5.46 for the past 6 months, there are some minority shareholders who felt shortchanged. Most of them argued that the tender offer price must be the same as the initial public offer price of P11.28 per share. A preposterous idea that is contrary to common sense. Although a historical cost method used in accounting in which the price of an asset is based on its original cost when acquired, the same cannot be used for the tender offer price for the reason that value changes over time. As Benjamin Graham stated, price is what you pay; value is what you get.

Save More

Philippine government must declare retirement as a national wealth emergency for the reason that most Filipinos are not prepared to do so. Even the law governing employment practices and labor relations are not enough to provide Filipinos with a decent retirement. Based on the Labor Code of the Philippines, the minimum retirement pay is 1/2 month salary for every year of service while a fraction of 6 months is considered as 1 year. The 1/2 month salary will include the 1/12 of the mandatory 13th month pay; 15 days salary based on the latest salary rate; and cash equivalent of 5 days service incentive leave. Manulife Investor Sentiment Index (MISI) conducted by the Canada-based insurance and financial services provider Manulife Financial Corporation showed that Filipinos have an average retirement savings worth 3.6 months while Asians have an average retirement savings worth 2.9 years. MISI is an annual survey measuring and tracking Asian consumer behavior related to personal financial planning. Respondents are middle class investors who are at least 25 years old and who are the primary decision makers on household financial matters. We are astounded by the low retirement savings of Filipinos but what concerns us the most is the reason behind it. MISI showed that the low retirement savings of Filipinos is based on the expectation that family members will support them upon retirement. We do know that strong family ties is one of the core values of Filipinos but what we do not know is whether Filipinos have a retirement plan when family ties get untangled. Filipinos must work toward financial independence with enough retirement savings to maintain their desired lifestyle even without a regular income. MISI showed that Filipinos believe that an average retirement savings worth 2.1 years is enough as compared to the ideal retirement savings worth 10 years. The ideal retirement savings is based on the average life expectancy of 70 as compared to the average retirement age of 60. Filipinos must start to save more to catch up with the ideal retirement savings for the reason that no amount is enough once the dreaded inflation sets in. Inflation is the rate at which the general level of prices for goods and services is increasing while the purchasing power of currency is decreasing. We must protect the purchasing power of retirement savings by investing in asset classes that can provide capital preservation and appreciation.

Bogus Broker

The year ends with a bang when the Philippine Stock Exchange (PSE) warned the investing public to undertake extreme caution and due diligence with respect to any solicitation of funds by companies that intend to be trading participants. PSE stated that there is no guarantee that such companies will be considered as trading participants as they will be required to undergo a comprehensive assessment based on qualifications under the law. Solicitation of funds by companies that intend to be trading participants may be considered a sale or distribution of securities in the Philippines that require registration with the Securities and Exchange Commission (SEC) under the Securities Regulation Code (SRC). Failure to obtain such registration subjects the seller of securities to civil and criminal penalties. Those who act as agents, dealers, brokers and salesmen in the solicitation of funds by companies that intend to be trading participants can be prosecuted and held liable under Section 28 of the SRC while penalties can be a maximum fine of P5 million or 21 years imprisonment or both under Section 73 of the SRC. Per the PSE Rules Governing Trading Rights and Trading Participants, the minimum qualifications for a company applying to be a trading participant is that it must be a duly registered domestic corporation authorized to transact as a broker or dealer in securities; must be composed of shareholders not exceeding such number under the law; and must have a minimum unimpaired paid-up capital of P100 million. PSE holds the right to assess the character of a company that intends to be a trading participant such as the reputation and qualification of its shareholders, management, nominee and other personnel. We do not know the reason why the PSE took time before warning the investing public about the solicitation of funds by companies that intend to be trading participants but what we do know is that this company is the financial technology startup known as Investagrams. In a gathering with the investing public on August 26, Investagrams announced its plan to launch an online stock trading platform known as InvestaTrade. Investagrams started a crowdfunding activity known as Investagrams Brokerage Pledge Campaign that provides benefits to donors depending on the amount donated. We must commend Investagrams for providing the investing public with free online stock trading products and services but the manner of funding an online stock trading platform does not justify the means.

Target Range

Philippine Stock Exchange (PSE) plans to require listed companies to disclose an offer price range for follow-on offerings of common shares. Pending determination of the final offer price the investing public must be guided by the offer price range in any transaction before the offer price setting date. Upon filing of the listing application, a listed company will be required to disclose in the prospectus the offer price range composed of a minimum offer price and a maximum offer price. The current listing rules do not require the disclosure of an offer price range for any type of public offering. By practice, listed companies planning to conduct a public offering indicate the maximum offer shares and the indicative offer price in their prospectus. Most investors are not aware that the indicative offer price is the maximum offer price and the final offer price could be lower than the indicative offer price. The proposed amendments to the listing rules will be limited to follow-on offerings of common shares because the minimum offer price is not determined by the issuer in Initial Public Offerings (IPO), the final offer price is determined by the issuer in Stock Rights Offerings (SRO) while the final offer price is not a material consideration in Preferred Shares Offerings (PSO). The proposed amendments to the listing rules came about when San Miguel Food and Beverage Inc (FB) filed with the Securities and Exchange Commission (SEC) a registration statement and preliminary prospectus for a follow-on offering involving the sale of 887 million common shares with an overallotment of 133.05 million common shares with an indicative offer price of P140 per share for a total of P142.8 billion. After the indicative offer price was set at an unreasonable premium the stakeholders adjusted it closer to the market price to make the follow-on offering marketable to the investing public. The underwriters reduced the follow-on offering involving the sale of 400.94 million common shares with an overallotment of 60.14 million common shares with a final offer price of P85 per share for a total of P39.2 billion. This could be uneventful to most investors but in the midst of the public debate on whether or not to require listed companies to disclose an offer price range for follow-on offerings of common shares, the bulls make money, the bears make money while the pigs get slaughtered!

Mega Sale

San Miguel Pure Foods Inc is renamed San Miguel Food and Beverage Inc (FB) after the P336.35 billion share swap transaction with San Miguel Corporation (SMC) involving the infusion of 216.97 million common shares of Ginebra San Miguel Inc (GSMI) and 7.86 billion common shares of San Miguel Brewery Inc (SMB) in exchange for 4.24 billion common shares of FB. As a holding company, FB now holds an ownership of 78.26% in GSMI and 51.16% in SMB while SMC now holds an ownership of 95.87% in FB. The underlying principle behind the consolidation is to create a business platform that can benefit from the shared synergies and unlocks the value of the combined business segments. In compliance with the Minimum Public Ownership rule, FB filed with the Securities and Exchange Commission a registration statement and preliminary prospectus for a follow-on offering involving the sale 887 million common shares with an overallotment of 133.05 million common shares with an indicative price of P140 per share for a total of P142.8 billion. Upon completion, the follow-on offering will be the largest in the Philippines and will make FB the largest consumer stock and an index component stock of the Philippine Stock Exchange. We believe that there will be strong demand for the follow-on offering since FB is considered as a proxy for the Philippine consumption due to its trusted brand names, broad product portfolio and leading market positions. FB can benefit from the stable economic growth, growing population base and consumer-driven economy. Based on the data compiled by the GlobalData, the household consumption expenditure as percentage of Gross Domestic Product is 73.5% while the addressable food and beverage market size as percentage of total food and beverage industry size is 41.8%. Moreover, FB had set a cash dividend policy of 60% of the annual net earnings, which is higher than the average dividend payout among listed companies. Through the combined business segments, FB plans to expand distribution network, enhance market penetration and increase production capacity to protect traditional markets and conquer emerging markets. But we believe that the follow-on offering indicative price of P140 per share as compared to the share swap transaction price of P79.82 per share is absurd. We do not know the reason why the follow-on offering indicative price was set at 75.4% premium but what we do know is that the underwriters will be forced to adjust it closer to the share swap transaction price to make the follow-on offering saleable to cornerstone investors in the midst of market unrest brought about by geopolitical tensions and macroeconomic headwinds.

Debt Trap

Philippines is set to increase government spending on infrastructure as percentage of Gross Domestic Product (GDP) via an P8.4 trillion infrastructure spending program. Based on the data compiled by the Department of Budget and Management (DBM) from 2010 to 2016, government spending on infrastructure as percentage of GDP averaged at 2.9%. DBM stated that the infrastructure spending program will increase government spending on infrastructure as percentage of GDP from 5.3% in 2017 to 7.4% in 2022. Out of the proposed 75 infrastructure projects, the National Economic and Development Authority stated that 35 had been approved while the rest are undergoing evaluation by the concerned government agencies. In order to finance the infrastructure spending program, the Philippines will need funding from international financial institutions, multilateral development banks and traditional creditor countries. But it had chosen the road less traveled by accepting the pledge by China to fund 18 infrastructure projects worth an estimated P731.7 billion. We must be aware that Chinese loans can be generous in the short-term but can be dangerous in the long-term. Chinese loans have interest rates between 2% to 3% while Japanese loans have interest rates between 0.25% to 0.75%. Moreover, Chinese-owned companies and Chinese workers rather than Filipino-owned companies and Filipino workers will be required to work on China-funded infrastructure projects. Known as the Belt and Road Initiative (BRI), China has been funding infrastructure projects in underdeveloped countries in exchange for diplomatic relations, natural resources and regional access. Based on a study conducted by the Center for Global Development, countries participating in the BRI that will default will find themselves in a Debt Trap. The study evaluated the present and future debt levels of the 68 countries hosting China-funded infrastructure projects and found that 23 countries are at risk of default. As the BRI expands in scope so do suspicion that it is a form of economic imperialism that gives China an undue leverage over underdeveloped countries. We must be concerned that its expanded commercial presence can lead to an expanded military presence as most of these China-funded infrastructure projects can be used for commercial and military purposes. China can use its leverage over the Philippines to expand its artificial islands in the West Philippine Sea and to support its territorial interests in the South China Sea. Entering into debt bondage with China is a wrong move for the Philippines.

Rule Model

Conservatism principle requires that losses are recognized when they are quantified and that gains are recorded when they are realized. But measuring impairment on financial instruments under the old financial reporting standards is not conservative enough to ensure the reliability of the financial reporting system. Impairment on financial instruments is recognized after rather than before the default, which overstates assets and earnings and understates liabilities and expenses. How unfortunate that this liberal recognition of impairment on financial instruments has been tolerated by the accounting profession to the detriment of the users of financial statements. But the days of overstated assets and earnings and understated liabilities and expenses are gone after the Bangko Sentral ng Pilipinas (BSP) approved the guidelines on the adoption of Philippine Financial Reporting Standards (PFRS 9) – Financial Instruments for BSP-supervised Financial Institutions (BSFIs). PFRS 9 is the local adoption of the International Financial Reporting Standards (IFRS 9) – Financial Instruments, which was issued by the International Accounting Standards Board as a replacement to the International Accounting Standards (IAS 39) – Financial Instruments: Recognition and Measurement. PFRS 9 requires BSFIs to incorporate material information in measuring impairment on financial instruments under the new financial reporting standards. BSFIs are required to assess the impact of PFRS 9 on business strategies and credit risk management systems to be able to adopt policies and procedures to ensure the reliability of the financial reporting system. Based on the guidelines on the adoption of PFRS 9, the BSP will evaluate the consistency of sales activities and metrics being used in monitoring the performance of financial instruments with the business model for holding the instrument. This will align the accounting treatment with the credit risk management systems to strengthen governance over the financial reporting system. PFRS 9 requires the adoption of an Expected Credit Loss (ECL) model in recognizing impairment on financial instruments to provide accurate information to the users of financial statements under the Guidelines on Sound Credit Risk Management. Under the ECL model, an allowance for credit losses at any balance sheet date is calculated by recognizing probable defaults within the next 12 months or for the entire remaining life of the financial instrument. The estimation of ECL will be a remarkable change in the financial reporting standards. Given the importance of BSFIs in the Philippine capital market, it is important for stakeholders to develop reasonable ECL estimates to ensure the accuracy of financial statement disclosures.

Cake News

Goldilocks Bakeshop scheduled Initial Public Offering (IPO) did not push through due to the elevated political and economic risks after the unexpected outcome of the 6 May 2016 general election. This made Goldilocks Bakeshop a legitimate Merger and Acquisition (M&A) candidate due to its remarkable economic moat. From a one-store bakeshop in Makati City in 15 May 1966, Goldilocks Bakeshop became a 579-store food retailing enterprise in the Philippines with branches in Canada, Thailand, and United States. When the political and economic storm calmed down, SM Retail and Goldilocks Bakeshop started negotiating for a proposed joint venture, equity investment or cooperation agreement. SM Retail is a subsidiary of SM Investments Corporation - a public conglomerate with business interest in retail, banking, property, and equity investments. SM Retail agreed to acquire a majority stake in Goldilocks Bakeshop for an undisclosed amount and the proposed equity investment was approved by the Philippine Competition Commission (PCC) on the condition that SM Retail will be subjected to random inspections by the PCC to ensure compliance in managing potential competition issues in the transaction. SM Retail must address any competition issues and any breach of the conditions will subject it to fines and other legal remedies. Under the Philippine Competition Act (PCA), the PCC is mandated to review M&A that breach the P1 billion threshold to ensure that these transactions will not abuse the merged business position by engaging in conduct that will prevent or reduce competition. PCA defines, prohibits, and penalizes undue dominant position, anti-competitive agreements, and anti-competitive M&A. But the proposed M&A went nowhere when SM Retail announced that it had abandoned its plan to acquire a majority stake in Goldilocks Bakeshop due to changes in the general business environment. We were taken aback when the proposed M&A was canceled and what confused us was the obscure reason for the cancelation. General business environment has been stable and favorable to M&A so it is bothersome to hear a lame excuse from a renowned retail conglomerate run by postgraduate-educated management team. Perhaps the PCC imposed unreasonable conditions to ensure free market system or the due diligence revealed the business shenanigans of Goldilocks Bakeshop. We do not know the reason why the proposed M&A was canceled but what we do know is that Goldilocks Bakeshop will remain a legitimate M&A candidate due to its remarkable economic moat.

Sold Down

Philippine Stock Exchange (PSE) had been condemned by the minority shareholders when it delisted Calata Corporation (CAL) due to violations of the disclosure rules under the Securities Regulation Code (SRC). Disclosure rules stated in SRC Rule 17.1 require a public company to file a current report to make an accurate disclosure to the public of every material fact or event that occurs which is expected to influence the investors decisions in relation to those securities. In the event a news report appears in the media involving an alleged material fact or event, a current report must be made within the prescribed period in order to clarify the news report that can create public speculation if not denied or clarified by the public company. PSE alleged that CAL had committed 55 violations of the disclosure rules from 6 October 2016 to 20 June 2017. First violation of the disclosure rules carries a fine of P50,000, second violation carries a fine of P75,000, third violation carries a one month trading suspension, and fourth violation will be a ground for delisting. CAL was fined a total of P300,000 and the PSE decided to start involuntary delisting proceedings. The imposition of monetary penalties and trading suspension are without prejudice to any regulatory action that can be undertaken by the regulators in connection with the violations. Despite the absolute violation of the disclosure rules, the minority shareholders are against the decision of the PSE to delist CAL due to the absence of an exit mechanism. To appease the minority shareholders, the PSE proposed voluntary rather than involuntary delisting on the condition that a tender offer will be conducted. CAL rejected the proposed voluntary delisting as it does not have enough retained earnings to buy back outstanding shares at book value per share. Although the tender offer price must be based on a fairness opinion valuation of the business, there are no rules under the SRC that pegs the tender offer price to the book value per share. PSE had bended the disclosure rules to accommodate an exit mechanism but CAL had chosen the road most traveled to enrich themselves at the expense of the minority shareholders. When corporate governance breaks down, minority shareholders must sell and never forget. Those who break the rules are scum but those who abandon those rules are worse than scum.

Market Watch

Philippine stock market performance as measured by the Philippine Stock Exchange Index (PSEi) has been considered as one of the most turbulent among the emerging markets. The term emerging market was coined by economists at the International Finance Corporation when they were promoting the maiden mutual fund investments in developing countries. An emerging market has the features but not the standards of a developed market so it can be upgraded to a developed market or downgraded to a frontier market at the discretion of the global index providers. The year that was had shown us that buy-and-hold strategy does not work in emerging markets unless we know the balance between the desire for the lowest possible risk and the highest possible return. Low levels of risk are associated with low potential returns while high levels of risk are associated with high potential returns. But high potential losses must be reckoned because there are no guarantees. We must not measure investment returns based on passive investment strategy where an investor buys and holds stocks even with observable market threats. But we must measure investment returns based on active investment strategy where an investor buys and sells stocks anchored on favorable market sentiment. Although the MSCI Emerging Markets Index opened at 794.14 points on 31 December 2015 and closed at 862.27 points on 30 December 2016 or an investment return of +8.58%, the PSEi opened at 6952.08 points on 29 December 2015 and closed at 6840.64 points on 29 December 2016 or an investment return of -1.60%. MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure stock market performance in emerging markets. Beyond reasonable doubt it was a bad year for passive investors but a good year for active investors. From the year low of 6084.28 points on 21 January 2016 to the year high of 8102.30 points on 21 July 2016, the PSEi made an investment return of +33.17%. But from the peak of 8102.30 points on 21 July 2016 to the trough of 6563.67 points on 23 December 2016, the PSEi made an investment return of -18.99%. PSEi had shown us that we must engage rather than evade market turbulence. But do not enter into uncharted territories unless the potential reward outweighs the potential risk. Before you jump on the bandwagon ponder that past performance does not guarantee future results.

Trade Wreck

Philippines is fortunate to have an economic growth anchored on consumption but is unfortunate to have an economic partner anchored on compulsion. Philippines and China had been ensnared in territorial dispute after China underscored the territorial claims in the West Philippine Sea that includes the shoals within the Philippines exclusive economic zone. Based on the United Nations Convention on the Law of the Sea (UNCLOS) an exclusive economic zone refers to an area within 200 nautical miles from the territorial sea of the coastal state. UNCLOS provides the regulatory framework for marine conservation, navigational rights, maritime zones and sovereignty. Due to the exhausted diplomatic channels the Philippines commenced arbitral proceedings to the Permanent Court of Arbitration but China refused to partake. As a signatory China agreed to refer the interpretation and application of the UNCLOS to the compulsory and binding dispute resolution procedure of the convention. By prohibiting reservations and adopting provisions on the basis of consensus it was the intention of the UNCLOS to eliminate the use of force in territorial dispute resolution among member states. Why did China refuse to partake? We do not know the answer but what we do know that prolonged territorial dispute could lead to adverse trade relations between Philippines and China. West Philippine Sea Coalition (WPSC) revealed that China warned the Philippines of economic consequences once it starts arbitral proceedings against them at the Permanent Court of Arbitration. WPSC was formed by the concerned citizens to protest absolute violations and pursue peaceful resolution of territorial disputes within the West Philippine Sea. Based on intelligence analysis these economic consequences could range from sanctions to sabotage. WPSC stated that parts of these economic consequences were the spontaneous import restrictions and strenuous inspection protocols imposed on Philippine banana exports to China. Based on the data compiled by Bloomberg the Philippine exports to China decreased to $19.02 billion in 2015 from $21.05 billion in 2014. Economic coincidence or economic consequence? Although the China economic growth as measured by the Gross Domestic Product (GDP) decreased to 6.8% in 2015 from 7.2% in 2014 China remains as the Philippines largest export market. Based on the data forecasted by the Development Budget Coordination Committee from 2014 to 2016 the average annual export growth is 8.0%. Perhaps the Philippines should manage export growth, expand export products and penetrate export markets before the China economic diplomacy agenda turns from bad to worst.